 Solutions to Problems

1. a. Cost of research: Five hours at $20 per hour $100

Research data 75
Total $175
b. Increase in expected return:
New return of 10%  Current return of 8%  2% increase
$10,000 investment  0.02 increase  $200
c. Yes; the expected increase in return is greater than the cost of doing the research.

Current closing market Current closing market

value of Stock 1   value of Stock 5
3. SP-6 Index 
Base period closing market Base period closing market
value of Stock 1   value of Stock 5
a. SP-6 Index  $460  $1120  $990  $420  $700  $320 $4,010
Jan. 1, 2010 $240  $630  $450  $150  $320  $80 $1,870
 2.144  100 214.4
SP-6 Index  $430  $1150  $980  $360  $650  $290 $3,860
June 30, 2010 $240  $630  $450  $150  $320  $80 $1,870
 2.064  100 206.4
b. The SP-6 Index has moved from 100 in the base year to 214.4 on January 1, 2010, and 206.4 on
June 30, 2010, which represents a gain of 114.4% and 106.4% respectively. The SP-6 Index fell
eight points, from 214.4 on January 1, 2010, to 206.4 on June 30, 2010. The general downward
trend indicates a bear (falling) market.

5. Mr. Cromwell’s market order to buy would have been filled at the lowest price available at the time,
while a sell order would have been filled at the highest price available at that time. However, since
market orders are executed quickly, it is reasonable to expect that Mr. Cromwell would have paid
$5,000 for his market order to buy a round lot (100 shares at $50 a share).
He would also have realized $5,000 for his market order to sell common stock. Of course, we have
ignored brokerage commissions and other incidental costs. On the NYSE, only one price is quoted,
and both buy and sell orders could be executed at that price.

7. The minimum loss that you would experience in this case is $3.50 per share, or $175, on the total
investment (50 shares at $3.50 per share). It is important to realize that this is a minimum loss. This is
because when the stock price falls to $23, the stop-loss order is converted to a market order to sell at
the best price available at that time. However, it is possible that the actual stock price might plunge
down further, in which case the stock would be sold below $23 per share (possibly at $20.50 in this
example). In this case, the loss would be $6/share, or $300 total.

9. Since the stock never fell to the limit order buy price, you never purchased it. However, you sold it at
$70 per share, so you are now short 100 shares. Because the stock is currently selling for $75, your
current position is a loss of $500.

Smart/Gitman/Joehnk, Fundamentals of Investing, 12/e Chapter 3

11. Probably nothing will happen. Although you placed a stop-limit order to buy the stock, and the limit
price was hit, you did not have enough equity in your account to make this transaction. Three
hundred shares at $50 per share would cost $15,000. You could make this purchase with $7,500 in
your 50% margin account but not with $5,000.

Smart/Gitman/Joehnk, Fundamentals of Investing, 12/e Chapter 3